In a battle for deposits, competition, not deregulation, drives record M&As
For much of 2018, various bank regulating agencies focused their efforts on easing the regulatory burden on the U.S. financial system. At the same time, we’re at or near the peak of a consolidation cycle. Conventional wisdom leads us to believe these are related: that it’s a causational relationship. But is that really the case?
We looked into the numbers and found deregulation has actually had little, if any, impact on driving bank mergers and acquisitions (M&As). Rather, the majority of this activity took place to achieve growth in a competitive market. While the biggest banks have enjoyed healthy organic growth, the reality is that for the rest of the nation’s banks, growth by acquisition is now the optimal path—and perhaps the only one—to compete in today’s environment.
Merger myths, acquisition actualities
One decade after the financial crisis, the number of FDIC-insured financial institutions has dropped by 32 percent: just shy of a third. M&A is the primary reason and the trend shows no signs of slowing down. Between the second quarters of 2017 and 2018, the number of federally insured financial institutions decreased 4.2 percent, from 5,787 to 5,542. That’s one of the largest industry consolidations since the financial crisis. In 2018, the FDIC reported 141 financial institutions absorbed by M&A activity, with none resulting from failure.
This came amidst favorable times for the banking industry, not only in terms of higher profits but also because of new charters and a sharp decrease in what the FDIC calls “problem banks.” This left many bankers wondering if continued deregulation efforts will speed up M&A or if other factors drive consolidation.
To answer this question, it’s important to understand the current environment in which banks now operate. For starters, total assets continue to increase for FDIC-insured institutions and banks have posted higher returns. The FDIC reports that overall bank return on assets has increased almost 25 basis points when comparing Q2 2017 to Q2 2018. While some of this growth came due to rising interest rates, asset quality also continues to improve (with a slight exception in consumer lending activity).
All of this translates into more profits to fuel M&A purchases, but it’s also necessary to consider the implications from the seller’s side of the transaction. Earlier in 2018, several M&A deals were predicated by the seller’s willingness to be purchased or merged into another financial institution. Acting in the best interests of shareholders and employees, these banks chose it as the right time to cash in on the value of their institution due to a favorable environment for M&A and the seller’s improved financial results. Some who chose this path promoted a sale with the purchaser paying premiums up to two and a half or even three and a half times the seller’s tangible book value.
Following their footprints
To prove that it was competition—and not deregulation—driving up levels of M&A activity, we conducted a mini-research project of its own, based in large part on what the banks themselves said publicly. We reviewed American Banker’s Capital Markets section and conducted further research into press releases by the acquiring or surviving institutions. Financial institutions ranged in size from small community banks to some of the largest regional banks in the U.S. For each M&A transaction, we classified by the acquiring or surviving institution’s rationale for the deal, as stated in their press releases.
Contradictory to industry predictions, the analysis confirmed that deregulation was not the largest driver for M&A in the documents reviewed from 2018. Rather, the most common reason cited was footprint expansion, which constituted the rationale for 52 percent of the reviewed population. Strategic fit followed with 21 percent. M&A to acquire a new business line or service that the acquiring or surviving institution didn’t have was third with 13 percent.
While there is no doubt most banks want to grow into new geographic markets, it was surprising to note that of the 21 percent of acquirers, most rationalized the deal by saying they were gaining clients from the purchased institution within their existing footprint. This rationale confirms the results of numerous studies conducted on the banking industry: entry into new geographies without M&A can be a costly strategy for organic growth—and within existing markets, competition is fierce. To gain new clients, banks either must attract organic growth with a competitive advantage or acquire clients with a merger or an acquisition.
As for deregulation’s impact on M&A? Only 4 percent of acquiring or surviving institutions cited this as their rationale, putting to rest the notion this accounts for the source of recent and heightened industry consolidation.
Parting shot: The M&A reality today
A deep dive into the numbers sheds light on the reality banks face today. Competition for deposits has never been this intense. The biggest banks in the U.S. increase their lead year after year in deposit growth. For the rest of the banks, remaining competitive poses a real challenge. For the time being, M&A will continue to serve as a mainstay in the quest acquire market share in a quick and often inexpensive way.
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